Flipping. It is a cool thing that startup founders and investors are excited about these days. This existed for a long time now, but at the moment it is becoming quite a trend in India, so if you want to work with startups and investors, this is something you would want to learn.
An increasing number of Indian startups are flipping their holding companies to other business friendly jurisdictions. Now we have a cool name for it as well. There are good reasons.
What is this all about?
What does it mean for lawyers? What do you want to know about flipping as a lawyer and how to help/ guide your clients?
At LawSikho, we keep our newsletter readers informed of the latest legal trends, and we will help you to understand the ramifications of flipping and specifically talk about a Delaware Flip.
It is often a good idea for startups, and businesses in general to have a holding company in a jurisdiction which has friendlier laws for businesses to thrive and run Indian operations as a subsidiary.
However, for investors it may mean a lot more. They often feel secure to invest in a holding company that is in a jurisdiction they are familiar with.
Many investors would never want to be a director in an Indian company, for instance, due to strict director’s liability laws here.
So if you incorporate a holding company in Singapore or Delaware, that can open up some investment avenues that are otherwise closed.
There may be a bunch of other benefits too, such as low tax on international sales, less capital gains tax at the time of an acquisition etc. There are also some corporate governance norms that make it attractive to investors or even founders.
It is increasingly important for startups to structure their businesses smartly.
The Economic Times article states that investors are keen to know how your business is structured even before knowing your business model.
Hence, flips are popular. It is also not something that every corporate lawyer is familiar with, so those who know how to guide clients through this are in demand and can charge a premium.
Today we will be talking about one of the most popular flips in the startup world, the Delaware flip.
If you are a business, company or a startup who caters to the US population or makes a product for the USA, or have international ambitions, this flip is even more relevant.
What is a Delaware flip
Here is what happens in a Delaware flip:
Most of the time, the Indian promoters will subscribe to securities in the US holding company incorporated in Delaware by offering shares in their Indian company on a share swap basis. This would result in the US holding company having 100% paid up capital of the Indian company and the Indian promoters holding a 100% stake in the holding company. The strange nomenclature of this kind of transaction also comes from this flipping of shareholding.
Delaware has the most sophisticated and comprehensive law when it comes to corporates in the United States. It is one of the most popular jurisdictions to register your company in, not only for US corporations but even many international companies.
Delaware is the most favourite among investors because the laws are predictable and certain even in complex situations.
- The rules of financing and governance of a corporation, such as terms of preferred stock (special class of shares with additional rights) and rules related to voting rights of investors are intuitive, predictable and very flexible.
- The stockholders of the Delaware corporation can act with only a simple majority vote while other jurisdictions look for unanimous or super-majority consent.
- A Delaware company can effect a merger with another company with the consent of a simple majority of shareholders. You don’t require the consent of the minority shareholders which may be attractive to a lot of investors. This can also be attractive to a potential acquirer.
- Furthermore, the assets of a Delaware corporation can be sold to an acquirer with the consent of the simple majority of shareholders.
- The advantages of choosing a US company also helps in listing on many stock exchanges.
- Delaware C corporations are synonymous with convenience and ease of doing business in the corporate world.
Apart from Delaware, Indian companies often flip themselves in Singapore as well, for similar reasons.
Why C corporations
It has been a norm in the US that a company has to be a Delaware C company before an investment is even considered.
They are preferred more over LLCs as the selling, transferring and changing ownership of LLCs is difficult.
Further, Delaware C corporations are even considered over Delaware S corporations as S corporations shareholders can only be US citizens, residents or just natural persons.
A VC firm will not be considered as a natural person.
It is even more appealing to VCs because C corps can issue various classes of stocks.
Preferred shareholders get higher dividends, can have extra voting rights and can also convert to common stock if the company goes public.
As the allotment of stocks can get innovative in this structure, it is easier to issue sweat equity to the long term-loyal employees.
Then there is the Delaware Court of Chancery, which has a reputation of siding with the good faith decisions of directors and the internal shareholders-board of directors conflict can be resolved amicably and quickly in these courts.
The Delaware law is just flexible, easier and fast. This reputation has been developed over centuries. That’s what makes it one of the best jurisdictions in the world for incorporation of world class companies.
Tempted to register a company in Delaware in case you have a business? That is exactly what drives business owners and investors to consider Delaware flips.
What are the considerations for a Delaware flip?
A non-US company can choose to form new Delaware C companies for a lot of reasons:
- The USA is a major source of investment in the form of private equity and venture capital.
- US investors often have a strong preference for IP that is located in the US.
- The world’s biggest stock exchanges including the NASDAQ or the NYSE are located in the United States, therefore it is easier to do an IPO if you are a US based corporation.
- A lot of VCs are not so familiar with the Indian company and securities law, and they would rather invest in a jurisdiction, under a legal system, that they are familiar with. It is not about where the business is located, but how their rights and duties are governed as directors or investors.
- Tax considerations matter, going public in India and then repatriating profits back to USA is a big issue.
- A lot of founders can move out of India and settle in the USA and obtain visas through this kind of structure. If you want to live in the USA, getting a visa in the USA is far easier if you run a US corporation that has raised money in the USA.
- Indian companies hiring most employees in India, generating IP or doing R&D in a far lower cost jurisdiction like India while selling products in the USA or Europe can very easily raise a lot of money in the USA due to massive competitiveness over local US businesses and arbitrage opportunities.
Legal issues to consider before flipping
Before an Indian company flips, there are the legal issues that need to be considered:
- Round tripping under FEMA, 1999: Round Tripping is basically sending funds out of India and then reinvestment of these funds again back in India. This is to be considered when the founders of a holding Delaware C remain resident in India. The Reserve Bank of India does not allow an Indian resident to set up an overseas company that will further set up an Indian subsidiary or acquire a foreign company that has invested in an Indian company under automatic route without getting specific approval for the same from RBI.
- If IP of Indian companies is transferred to the holding company, it has to be done at a fair price and correct valuation as per Indian law, which can be tricky as Indian authorities frown upon value being shifted out of India. What is considered fair price today at an early stage of a business may be considered very low later at a stage when the business has grown much larger, triggering tax officers to question the valuation at the time of flipping.
- If the flip involves transfer of shares, which is often the case, you would have to pay capital gains tax. In the early stages, the shares will be cheaper and therefore the tax bill would be far less rather than a flip at a stage where you have received many rounds of funding or the business has become profitable and large.
- If the founders remain resident in India, then another difficult question may arise. Is India the effective place for management of the business? If that is the case, the foreign company becomes taxable in India.
A company is considered to have active business outside India when (a) its passive income (understood as an aggregation of sale and purchase transactions between related parties, royalty, interest, dividend, capital gains) is less than 50% of its total income; and (b) the number of employees in India, value of assets in India and payroll expenses relating to Indian employees is less than fifty percent of the company’s total employees, assets and payroll expenses over the last three years.
A company having an active business outside India is presumed to be non-resident as long as majority of its board meetings are held abroad.
For all other companies, the investigation of residence would involve identification of (a) persons who are responsible for management decisions and (b) place where decisions are actually made.
This makes it very hard to avoid Indian tax laws unless you have more than 50% of your business outside India as a matter of fact.
What are the downsides of doing such a flip
- The tax implications are complicated to handle: any failure to comply with specific regulations regarding the securities markets of the US could result in adverse consequences or loss of tax benefits. Finding lawyers in India with this knowledge is hard, and US compliance specialists and lawyers come at a pretty price.
- When the company agrees to form a holding company in Delaware, they are exposed to litigation in the United States courts. For instance, people may choose to file class action suits against you in the USA for things you have done in India. That includes shareholders!
- If the company wishes to list on a Non-US stock exchange, the US holding company may complicate the compliance processes.
Want to learn more about such kind of legal work? We can teach you!
A lot of venture capitalists and private equity investors are major clientele for this kind of business restructuring. As you may have guessed, this is one of the many things that a general corporate lawyer does for their client. Tax lawyers would also want to learn more about these transactions for obvious reasons.
As the startup space matures and we increasingly attract foreign investments in the country, apart from Delaware flip, Singapore flip is also becoming one of the major routes for a lot of startups. Even Flipkart was incorporated in Singapore.
In the future, a huge majority of Indian startups and even large companies will look to do business abroad and such flips will make great sense. Would you be the expert to help them?
Learn these transactions and a lot more with a LawSikho course. We make sure that you get robust training and develop the right skills to help your clients get the best of advice.
Needless to say, the skills required for such a flip is taught in our mergers and acquisitions course. I would also suggest you look at the corporate taxation, securities and insolvency courses to be a well rounded corporate lawyer in the coming times.
If you want to buy multiple courses, the Master Access library is a great choice, although the enrollments close on 30th September and we have just 3 slots left as of today.
Here are the courses that are open for enrolment:
- If you are interested in corporate governance, you should check out the diploma in Companies Act, Corporate Governance and SEBI Regulations;
- If you want to get that in-house counsel job, go check out the diploma in Business Laws for In-House Counsels;
- If Industrial and Labour Laws interest you, go take a look at that diploma course;
- The Intellectual Property, Media and Entertainment Laws will be booming in the coming times, if you’re inclined towards that career, check out that diploma course;
- If you’re sure that your niche lies in M&A, Institutional Finance and Investment Laws (PE & VC transactions), go check out that course;
- The Cyber Law, Fintech Regulations and Technology Contracts is in dire need of good young talent if that is what ticks for you, go check out that course; and
- Every young lawyer should check out our diploma course in Advanced Contract Drafting, Negotiation and Dispute Resolution.
Check out our other executive courses which can be helpful:
- We have a certificate course in Advance Corporate Taxation;
- You can also check out this course for Insolvency and Bankruptcy Code;
- If Trademark, Licensing; Prosecution and Litigation interest you, we have a course for that;
- LawSikho also teaches Competition Law, Practice and Enforcement in a course;
- Technology Contracts will be essential to every business in the future, you can check out that certificate course; and
- Knowledge about Banking & Finance Practice: Contracts, Disputes & Recovery is essential for every BigLaw layer, you can check that out too.
Have you heard about our webinars?
LawSikho offers amazing webinars that you can attend and learn from, with no charges, every day. Now we are even giving certificates to those who attend the full webinar. Check out some of our past webinars here: https://www.youtube.com/c/LawSikho/
While you can see past recordings of webinars on our YouTube channel, to participate in one personally is quite a different experience, as you can ask questions and interact with such amazing speakers and even other attendees. How can you attend these webinars in person? Sign up over here.
LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: